Reviewing and Understanding Costs – A Guide for Business Owners

As the end of the year is quickly approaching, it’s important to take a step back and review the cost of running your business. It’s essential to periodically review business costs, especially in times like these, as we continue to experience price increases, supply chain pressures, and continued inflation.  Most businesses no matter what size, will have experienced considerable price increases over the last 12 months and so its important to ensure that costs are being kept to a minimum, and that the business is still viable.  A financial forecast provides the perfect opportunity to review all costs across the entire business. There are three main costs to consider: Direct costs, fixed costs, and variable costs. Direct costs, also known as costs of sale, are the expenses incurred in making a sale. Fixed Costs, on the other hand, are the expenses that are the same every month, such as rent, rates, and insurance.  Variable costs are the expenses that fluctuate each month, such as travel and conferences. Taking time to review all costs can help identify areas where money is being spent unnecessarily, allowing you to make changes that can ultimately improve the overall financial health of your business. In this blog we will delve deeper into each of the areas.

Direct Costs

As a business owner, it’s important to understand the total cost of making a sale. Cost of goods sold (COGS) or direct costs, as they are also known, include all the expenses incurred in producing and delivering your product. The nature of these costs varies greatly depending on the type and size of business you are running.  For manufacturing-based companies, the costs often include raw materials, labour, shipping, and other consumables.  Service-based businesses, on the other hand, mainly incur more professional service based supply costs such as paying their staff and contractors. If you manufacture a product, what fulfilment costs and assembly costs do you incur? Do you have a clear view of all of your manufacturing overheads?  What, if any, warehousing, packaging and distribution costs do you have? And let’s not forget about labour costs. Can you streamline processes to reduce the amount of time and money spent on labour? Another area to focus on is your raw material costs. Can you find a more cost-effective supplier? Are you purchasing the right quantities to minimise waste? And don’t forget to examine your manufacturing overheads.  Having a clear understanding of your direct costs is critical to determine your gross margin, which is essentially cost of goods sold (COGS) before you consider fixed costs and overheads. Your sales must generate enough revenue to cover these expenses, and your direct costs serve as a great base for analysing your business performance.

Fixed costs

When planning for the next year, it’s important to take a closer look at your fixed costs. Fixed costs are costs which are the same every month. They do not change, even if you produce more or less each month. Examples of monthly expenses include rent, rates, and insurance. Although these costs tend to be contracted for a certain period of time, you might be surprised at the potential savings you can find by reviewing them. It can be surprising for example how many subscriptions and memberships you are paying for and not using. Are there ways to reduce these costs without compromising the quality of your offer? Taking a critical look at fixed costs will not only help you cut unnecessary expenses, but it will also ensure that you free up any resources you need to invest in growth.

Variable costs

When it comes to managing finances in a business, the budget can quickly spiral out of control if you don’t keep an eye on the more hard to predict expenditures. So, one cost group that can be particularly tricky to manage is operating variable expenses. These tend to include a range of fluctuating and activity-based costs such as travel expenses, entertainment expenses, marketing expenses, advertising costs and sales commissions.

However, despite their sometimes-unpredictable nature, variable costs also often fall into the bracket of discretionary costs and are probably the easiest cost group to influence. For example, if times are tough, you may be able to avoid travel and do meetings online. On the other hand, if times are good, you could treat the team to a night out. By having a handle on these costs and an idea of the most you’d like to spend in a forecast, you can avoid overspending and keep your business finances in check.

Planning  Ahead

2024 is likely to be as challenging as 2023 in terms of cost management.  As a business owner or finance professional, understanding costs is key to maintaining profitability. There are various types of costs in business that you must review and understand in order to make informed decisions. Costs should be separated out into fixed, direct, and variable costs. It’s important to differentiate between these costs and understand how they may fluctuate over time. This way you can understand the changing nature of your costs year on year and work out where to focus any cost reduction or monitoring exercises. Forecasting tools such as Clearview help you to get an accurate and speedy view of your future finances and can help you to predict the businesses viability. By reviewing your costs regularly, you’ll be better equipped to control your spending and make adjustments quickly as needed. With a solid understanding of the different types of costs in business, you’ll be well on your way to being resilient and running a successful and efficient operation into 2024 and beyond.

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